DP6520 News and Business Cycles in Open Economies
It is well known that the neoclassical model does not generate comovement among macroeconomic aggregates in response to news about future total factor productivity. We show that this problem is generally more severe in open economy versions of the neoclassical model. We present an open economy model that generates comovement both in response to sudden stops and to news about future productivity and investment-specific technical change. We find that comovement is easier to generate in the presence of weak short-run wealth effects on the labour supply, adjustment costs to labour, and/or investment, and whenever the real interest rate faced by the economy rises with the level of net foreign debt.